Week in Review
Global equities strengthened last week while fixed income struggled. Although international stocks were stronger in their home currencies, a stronger U.S. dollar weighed on returns for U.S. investors. On the other hand, emerging markets continued their recent strong performance as Chinese shares entered into a new bull market.
The economic highlight of the week was Friday’s payroll report, which showed a much larger-than-expected number of jobs created in October: 271,000. Bonds sold off on this news, while the U.S. dollar strengthened as investors anticipate the Federal Reserve (Fed) will raise interest rates in December. The stronger dollar also weighed on commodity prices.
In corporate news, earnings reports continued to trickle in. Nearly 90% of the S&P 500 has reported, with 74% of companies exceeding earnings estimates. Excluding the energy sector, earnings have grown 4.5% this quarter.
The U.S. Labor Market
Friday’s jobs report was completely unexpected, to say the least. The highest economist estimate of those surveyed by Bloomberg was 250,000, and the report came in at 271, 000 jobs created in October! Revisions were also made to prior months. One of the strongest parts of the report was wage growth, which accelerated 0. 4% month-over-month, double what was expected.
Continued improvement in the labor market has many convinced that the Fed has the “all-clear” to raise interest rates in December. There are, however, some important aspects of the labor market the Fed should take into consideration before acting too abruptly.
There are two major measures of unemployment in the U.S. – the U-3 rate and the U-6 rate. The U-3 rate is the commonly quoted gure that currently stands at 5%. The U-3 rate measures unemployed people as a percentage of the labor force. The U-6 measure is much broader. It includes “discouraged” workers and part-time “underemployed” workers, who would like to be full-time . While the U-3 rate has recovered nicely since the great recession, the U-6 rate is still above the level of past Fed tightening cycles. Until more of these discouraged and underemployed workers find work, we would expect the Fed to be slower raising rates when it does start. Luckily, job openings have reached their highest levels in nearly two decades, so those looking for work may have better opportunities going forward.
Quality is (Still) King
One of CLS’s major investment themes over the past couple of years has been quality. As our CIO, Rusty Vanneman mentioned in the monthly market review, multiple measures of quality have been working and working well in 2015.
Low-quality companies, those with high debt loads, poor returns on their equity and assets, and inconsistent earnings have managed to perform well since the bottom of the nancial crisis. Easy monetary policy had been a definite tailwind for these firms, but that began to change last year. The market began to punish low-quality firms as their earnings stalled, commodity prices collapsed, and the outlook for somewhat tighter monetary policy surfaced. Quality companies took back the market leadership they are accustomed to in these types of environments.